Oil Prices in India

This post is of less relevance now that oil prices have been deregulated. Anyway, you can get the perspective if they are brought under control next time when international prices become volatile. P.S--I'll update Tables & Graphs after I have more concrete statistics.

There has been a lot of discussion about the falling (now stable) oil prices and their impact on the Indian Economy. While there is a lot of relief that this has brought to the Indian Economy, especially by freeing some of the government expenses, there are some negatives like dropping revenue from export of petroleum products. Moreover, the security of jobs of Indians working in Middle East countries is also at risk if the decreasing revenues of oil producers leads to reduction in workforce. There are a lot of sources from where one can read more about the possible scenarios, some of which I've mentioned at the end.

This blog post is intended to elucidate the build-up of oil prices in India. There is a common misunderstanding that since the prices of crude oil have fallen by more than half in the previous 1 year (starting June 2014), there must have be a proportionate decline in the prices of final products like Petrol and Diesel. However, this is not true and also cannot be true. To understand this, let us deconstruct the price of common petroleum products - Diesel & Petrol.

1st it should be noted that market price of Petrol is decontrolled since 2010. Therefore, the Oil Marketing Companies are theoretically free to charge any price they wish from the consumers. However, the price which they charge consumers is not arbitrary and there is a precise methodology to arrive at the retail price of petrol and other final products. In any case, even when they were controlled, i.e. OMCs were required to sell at the government determined prices, they were collecting the government subsidy. The subsidy received or the under-recovery made by the OMCs is/ was the difference between desired price and actual price. So let us look at how are the prices determined and what all makes up for the price of petrol.

The hydrocarbon production-supply chain is basically made of 3 parts:

1. Extraction of crude oil from well.
2. Refining and 'breaking' of crude oil into various products such as LPG, Petrol, Diesel, Waxes, etc.
3. Retailing of refined products to the end user.

At each of these stages, the subsequent user pays a cost based on different factors making the 'price-discovery' at each stage a dissimilar process.

As in any market, it is not merely the demand-supply equation that determines the prices. As such, Crude Oil prices also depend on factors like expectation of future demand, competition from other sources of energy, geopolitical stability in supplier regions, speculators in international commodity markets, whims & fancies of oil cartels, etc. As such they are vulnerable and volatile (as is evident from their fluctuations recently). Different international supplier markets have different prices that are quoted daily. Publications like Platts and Argus media are examples of agencies providing information about crude oil prices prevailing at various 'spots'.

Indian refinery sector has shown remarkable improvement because of reforms in the pricing of petro products, and as such our refineries meet the total domestic requirement, even exporting finished petroleum products. Even though only about 7% of total output is exported, it forms the largest component of India's exports in value terms. Refineries purchase crude oil from the producers at FOB (Free-on-board) prices and incur the freight, insurance and other costs (like port charges). The total landed cost for refineries also include the customs duties which they pay (currently customs duty on crude oil is nil + Rs.50 NCCD). Now comes the most contentious, but little understood step in oil pricing.

Crude oil produces different products on 'cracking'. These are differentiated based on their density and evaporation point. Since Crude oil is not uniform in composition every time, there is a variance in the ratios of final products obtained. The following chart is just an example of how much proportion of what is obtained. Please note that it can vary significantly well-to-well from where the oil was sourced.

Depending on the market value, some of the products sell at a higher price than crude oil and some at lower. The Petroleum Planning and Analysis Cell (PPAC) estimates the following average price of all the products sold. It can be seen that on an average, crude oil which costs 100 units, sells for 104 units post refinement. The Refinery Gate Prices (RGP) of products are what the marketing companies pay to the refineries.

The downstream sector (refinement + distribution + marketing) in Indian PSUs is integrated and the OMCs, such as Indian Oil account for more than half of the total refinery output. Joint sector and private refineries such as Reliance also sell to the OMCs at the RGP and export the surplus (that which is more than requirement of the OMC).

To arrive at RGP of a refined product certain guidelines have been laid depending on the product concerned. In case of Petrol and Diesel, RGP is arrived at the basis of Trade Parity Price (TPP). TPP was the 80:20 weighted average of the IPP and EPP (Import Parity Price and Export Parity Price) in case of Diesel before being deregulated. In a market where Import and Export of a product are freely permitted, the domestic price of a product would be set by the domestic demand and supply situation. If supply exceeds demand then the net realisation by the producers in the domestic market would have to be at least  equal to the net realisation through exports. If demand exceeds supply, net realisation by the producers in the domestic market would be capped by the price consumers would have to pay is the product were to be imported. Loosely, one can say that if supply exceeds demand, domestic price would be governed by the EPP (FOB price at India) and if demand exceeds supply, the domestic price would be governed by IPP (CIF price). Although, broadly it can be stated that trade parity price depends on the elasticity of demand and would be weighted average of domestic price and IPP, with weights being determined by proportion of supply being consumed and imported, there are numerous complications in a diverse market like India. It is important to take note of the exact manner in which IPP, EPP and TPP are calculated:

1. IPP - Import Parity Price represents the price which importers would pay in case of actual import of products at the respective Indian port and includes following elements-
1. Free On Board (FOB) price
2. Ocean Freight & Insurance
3. Custom Duties
4. Port Dues, etc

2. EPP - Export Parity Price represents the price which oil companies would realise on export of petroleum products. This includes-
1. Free On Board (FOB) price
2. Advance Licence Benefit (ALB) for duty free import of Crude Oil pursuant to export of refined products. Consequent to abolition of Customs Duty on Crude Oil effective 25.06.2011, the ALB is currently zero.

3. TPP -Weighted average of IPP and EPP based on proportion of consumed and exported.

After Oil is bought from the refineries, it is transported to other parts of the country. Along with freight, other costs like Marketing costs are recovered from the dealers (depot/ wholesaler or retailer). Excise duties are added along with the government specified dealer commission. VAT is added which is the decided by the state government. Local taxes, if any, such as Octroi or Entry Tax, BMC charges, etc. are added and retail selling price of fuel is arrived at. 

Here is the breakup I tried to create in Excel from some free reports available at Platts and Argus website and different sources from Government of India (MoP&G)

Price Build-up of Petrol at, say, Lucknow (FOB Prices are of December 9, 2014 from a free report available at Platts)
Sr. No.	Elements	Unit	Effective 9th Dec'14	Price Acc to Indian Oil as on 1st Feb 2015	Elements4	Description
1	FOB Price at Arab Gulf of Petrol/ Motor Spirit/ Gasoline	$/bbl	70.49		FOB Price	FOB (Free on Borad) daily quotes of Jet/Kerosene at Arab Gulf including premium / discount published by Platts and Argus publications are averaged for previous month.
2	*Add: Ocean Freight from AG to Indian Ports	$/bbl	2.18		Ocean Freight	Ocean freight from Arab Gulf to destination Indian ports as per world scale freight rates adjusted for AFRA.
3	C&F (Cost & Freight) Price	$/bbl	72.67	67.09	159	Rs/$ = 63.26  |  1bbl = 159 ltrs.
4		Rs./Litre	28.91	26.69
5	*Import Charges (Insurance/Ocean Loss/ LC Charge/Port Dues) (Petrol Data is not available, so have substituted Diesel Data)	Rs./Litre	0.45		Import Charges	Import charges comprises of Insurance, Ocean Loss, LC Charges & Port dues applicable on import of product.
6	Customs Duty - - Basic Customs Duty @ 2.5% - Countervailing Duty @ Rs2.70/ltr + Rs.6.00/ltr SAD - Additional Customs Duty @ Rs2.00/ltr	Rs./Litre	11.43		Customs Duty
7	Import Parity Price (Sum of 3 to 5)	Rs./Litre	40.80		Import Parity Price (IPP)	IPP represents the price that importers would pay in case of actual import of Petrol/ Diesel at the respective Indian ports.
8	Export Parity Price (FOB Price at India for Petrol + Advanced License Benefit for duty free import of Crude Oil)	$/bbl	71.48
		Rs./Litre	28.49
9	Trade Parity Price (80%Import Parity Price + 20%Export Parity Price)		38.34
10	Refinery Transfer Price (RTP) on landed cost basis for BS IV Petrol (Price Paid by the Oil Marketing Companies to Refineries)	Rs./Litre	38.34	27.26	Refinery Transfer Price (RTP)	RTP based on Import Parity Price, the price paid by OMCs to refineries.
11	*Add : Inland Freight and Delivery Charges	Rs./Litre	1.00	Sum Should be 33.68-27.26	Inland Freight & Delivery charges	It comprises of average freight from ports to inland locations and delivery charges.
12	*Add : Marketing Cost of OMCs	Rs./Litre	0.69		Marketing Cost	Marketing Cost & Margin are as fixed in the 'PDS Kerosene and LPG (Domestic) Subsidy Scheme, 2002'.
13	*Add : Marketing Margin of OMCs	Rs./Litre	0.71
14	Total Desired Price (Sum of 10 to 13)-[Excluding Excise Duty, VAT and Wholesale & Retailer Commission]	Rs./Litre	40.74
15	Less : Under Recovery to the OMCs [Excluding Excise Duty, VAT and Wholesale & Retailer Commission]	Rs./Litre	0.00		Subsidy by Central Government
17	Price Charged to Dealers (Depot Price) (14-13)- Excluding Excise Duty & VAT	Rs./Litre	40.74	33.68	Excise Duty
18	Add : Excise Duty - @ Rs.15.40/ltr - Basic Excise Duty @ Rs.6.95/ltr. - Additional Excise Duty (Road Cess) @ Rs.6.00/ltr - Special Additional Excise Duty @ Rs.2.00/ltr - Education Cess @ 3%	Rs./Litre	15.40	15.40
19	Add : Wholesale & Retailer Commission and Other charges fixed by State Government Dealer's commission @ Rs.1390/KL +.883% of Product Billable Price	Rs./Litre	1.89	2.03	Wholesale & Retail Dealer Commission and Other charges fixed by State Government	Commission fixed for Wholesale & Retail Dealer and other charges like delivery charges by District authorities / State Government.
20	Add : VAT (including VAT on Wholesale & Retailer Commission) @ 26.80% in UP	Rs./Litre	11.42	9.57	VAT (Sales Tax)	VAT at applicable rate in respective State. It varies from state to state
21	Retail Selling Price at Lucknow (Sum of 17 to 20)	Rs./Litre	69.44	60.68
	*Exchange Rate	Rs./$	63.26

Sources:

Impact of fall in Crude Oil prices -

http://www.businessinsider.in/Here-Are-The-Big-Winners-And-Losers-Of-Low-Oil-Prices/articleshow/44942790.cms

http://marketrealist.com/2014/12/indias-inflation-reacted-fall-crude-prices/